What Makes Us Overbought

Looking at the chart below of the 10 day moving average of the NYSE Advance-Decline line it is easy to see that we are overbought:

However, the reason we are maximum overbought is not because of the chart above. After all, every rally stops at different levels of overbought. Some at higher levels and some at lower. The reason we are overbought is because of the raw data that goes into this 10 day moving average. Below are the numbers being dropped from the 10 day moving average over the next 10 days:

For the next 4 days we will be dropping large positive numbers. The numbers replacing them are likely to be lower making it likely that we are now at the maximum overbought point. The trick for the bulls will be to get past the next 4 days without too much damage. After that the numbers become more mixed.

For over a half a year every overbought reading has led to a large decline. This does not necessarily need to be the case. Overbought readings can be worked off by going sideways or correcting by a small amount.

In the sentiment arena we have gotten some troubling numbers overnight. The AAII bears dropped to the lowest level in years. Additionally, Rydex traders are at their largest net long exposure since this rally started. This adds to recent data that shows the Investors Intelligence bulls at 50%, which is on the high side but not extreme. Additionally, the put/call ratios are overbought.

Anecdotally, I am not seeing that much bullishness and believe large investors are positioned conservatively. I don't believe this overbought reading will lead to a large decline. But I will heed the numbers and try to refrain from adding back trading longs until we are closer to having worked off this overbought reading. I am keeping my medium sized core net long position in tact.